Financing a Major Renovation

The crucial moment came early Saturday morning. The Prentices had driven up Friday night to Tahoe to stay for a week at their log home, and Sally wanted to get a head start on a gardening project. Digging into the earth at the back of the house, she realized the foundation was in trouble. It was evident that the south side of the home, which they’d been meaning to refinish for years, had lost its protective coating. Not only was there sun damage, but it looked like termites had gotten in as well.

Within an hour, she and her husband Sam sat down to figure out how to fix the problem. Originally, they’d intended on renting a pressure washer and doing the refinishing job themselves, but with several sections — including a corner — that needed to be cut out and replaced, that was no longer possible. The situation also seemed like an opportunity to expand the deck and lighten the overall log color.

They began searching for companies to work on the project. By the end of the week they had three bids for the job, running from $61,500 to $75,000. “We were in sticker shock,” said Sally. “We knew it was going to be expensive, particularly since we’d fallen down on our maintenance, but this is only a 2,000-square-foot home, and the logs themselves didn’t cost that much when we built it.”

Still, they had to admit that they were thinking of log values from 10 years ago, and cutting out and rebuilding is actually a more complex and time-consuming job than building fresh. And, they mused, they’d have a home that looked brand new with a huge deck — worth the investment. They went with the middle bid of $69,000.

The Prentices’ next challenge was to figure out how to come up with the funding. That kind of money wasn’t just lying around in a bank account. Neither did they have credit card accounts with check writing privileges that would cover that large an amount.

Restoration financing

If a restoration project comes along for log-home owners, the first thing to do is check with the contractor to see if the company offers financing. Not many restoration contractors are big enough to be able to finance the work, but some do.

The advantage to contractor financing is usually that it’s faster to get, and sometimes quite competitive. Be aware, however, that the many of the contractors who offer financing have higher rates than your traditional home mortgage rate, and they need to be paid off in three to five years — another factor to making their monthly payments high.

The next possibility is to refinance your existing first mortgage on the home. The Prentices, however, had taken out a 5% 30-year mortgage when rates hit bottom two years ago, and they didn’t want to roll the existing first amount plus the $69,000 into today’s higher rate.

Solution: A second mortgage or a homeowners line of credit?

Using your home equity to pay for restoring, refurbishing, or redesigning your home makes sense. Even the tax man gives you a homeowners’ interest write-off for up to $100,000 financed.

These loans are issued by almost all traditional mortgage lenders, are easy to find, are simple to compare with other rates, and are easy to qualify for. Unlike the home construction loan, your application process doesn’t usually need you to submit contractor’s credentials and contract or a detailed professional appraisal.

Look for them with your existing mortgage holder and compare to the rates and deals listed in the home section of your local newspaper. At this point I can’t advise checking the internet, as the big sites like LendingTree and BankRate have turned over their great search engines to the advertisers who insist on getting your personal information in return for giving you a couple of mortgage brokers who may or may not be experienced in your kind of loan.

The hardest thing to figure out is which kind of loan you should get: the variable interest line of credit or the fixed payment second mortgage. Here are the major differences:

The HELOC (Homeowners Line of Credit)

HELOCs are popular with homeowners doing major work on their primary or secondary home because:

They’re easy to get. Many people (including my husband and me) who financed or refinanced during the cheap mortgage money years often got a HELOC at the same time because mortgage brokers were able to set it up using just one credit application and no application fee.

You don’t have to pay interest on money you’re not using. When we got our credit line, for example, we envisioned installing a second story back deck that was probably going to cost $50,000 or so. We’ve still not gotten our permit through, so not having to pay interest on our still-untouched HELOC is a huge advantage.

As you can see from the accompanying Line of Credit vs. Second Mortgage evaluator, not having to pay interest on money you don’t need has an even greater advantage if you’re planning on selling or refinancing your first in the next three to five years.

However, HELOCs do have some drawbacks.

The biggest problem is the risk of interest rates going up. HELOC interest rates fluctuate and this is a double-edged sword. On the one hand, their rates are always less than rates on a second mortgage, simply because the lender knows that if rates go up, your payment will go up.

HELOCs often have payoff schedules of three to seven years, making the monthly payments for a home makeover much higher than they would be on a second mortgage with a 15- to 20-year payoff term. Most loan agents will advise you of this, and sometimes they’re able to offer a HELOC with a much longer payback period that will bring the monthly into manageable range. These are particularly attractive if you intend to pay the loan off early with a sale or refinance.

Second Mortgages / Home Equity Loans

Second mortgages (sometimes called a home equity loan, instead of a line of credit) are also fairly easy to find, and they’re ideal for the Prentice situation with an expensive project that has to be accomplished in a short period of time. Their advantages are:

You get a fixed rate payment for the entire period of the loan. Although rates are higher today than they were three years ago, they’re still at historic lows, and it’s nice not to have to worry about big fluctuations in payments from month to month.

These loans are typically amortized over 15 to 30 years, keeping your monthly payment lower than a HELOC’s five- to seven-year payback period.

The application process is a little more detailed and complicated than the HELOC application, but most lenders offer their home mortgage seconds with low to zero origination fees and only a few service fees.

The drawbacks to a second mortgage are:

The interest rate may work out to be higher than what you can get with a HELOC.

You may have to pay interest on money you don’t need yet. If the Prentices anticipate they may not be able to get the deck permit till next year, for example, they’ll need to recalculate the costs between doing the HELOC and the second mortgage.

The longer amortization/payback period means more interest overall paid to the bank — in the Prentice case, a $69,000 loan costs more than $115,000 to pay back.

The decision between a HELOC and a second mortgage will be based on your plans for your home over the next few years, plus your outlook on what will happen to interest rates.

Shari Steiner is a licensed real estate broker, speaker, and the co-author of Steiner’s Complete How-to-Talk Mortgage Talk and Steiner’s Complete How to Move Handbook. She helps people find dream homes and work up their finance requirements. Ask her questions on the www.movedoc.com website.

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